Memorandum from the Combined Heat and
Power Association (CHPA)
The Association welcomes the opportunity to
make an additional submission to the Environmental Audit Committee
inquiry into sustainable energy.
The Association submitted its original memorandum
to the Environmental Audit Committee in January 2001. This supplementary
note updates the Committee on developments since then.
All the major developers of CHP have withdrawn
from the market or put their development work on hold in the period
since NETA "Go-live" in March 2001.
For instance, the UK's two largest developers
of CHP projects, Innogy Cogen and Powergen CHP have announced
their decision to cease the development of new CHP plant. Together
these companies have developed approximately 25 per cent of the
UK's present CHP capacity. Powergen's decision follows a period
of 10 months during which the company were actively seeking a
buyer for their CHP business.
The New Electricity Trading Arrangements (NETA)
came into effect on 27 March 2001. The effects of this reform,
driven by a joint committee of the DTI and OFGEM, have been dramatic
upon many forms of sustainable generation, including CHP. This
was widely predicted and communicated to Government by many organisations
and companies in the two-year run-up to NETA.
Ironically, in commissioning the programme of
reforms, the Government asked the Energy Regulator to be sure
that when the new trading arrangements came into effect they would
". . . encouragement for Combined Heat and
Power and renewables generators."
Source: DTI Press Release, 8 October 1998.
At the time of NETA "Go-live", in
response to concerns raised by the sustainable energy community
over the impact of NETA immediately following its introduction,
the Government asked OFGEM to undertake a review of the impact
of the first two months of NETA upon small generators.
This report found that power exports from CHP
had fallen by 61 per cent under NETA. It also reported that prices
paid for power exports had fallen by 13 per cent, but noted that
this may not be a fair representation since most of these contracts
would have been negotiated before NETA went live. This suggests
a fall in revenue to CHP plant of some £140 million in its
NETA has had the effect of increasing CO2 emissions
by stimulating the use of conventional fossil-fuelled power plant.
Recent media reports
suggest that NETA has driven changes in operating practices for
conventional fossil-fuelled plant that will increase CO3 emissions
by 270,000 tonnes/year.
As experience of NETA grows, there is growing
cause to question its validity as an economically efficient or
fair means of operating the electricity network. A report submitted
to the PIU,
and considered by the DTI's "Consolidation Working Group",
raised the following:
the theoretical settlement costs
imposed by NETA upon wind farms (and by implication other small
generators) far exceed the actual cost to the National Grid Company
of technically "balancing" the electricity system;
optionmay be effective in reducing the theoretical settlement
costs for these generators. However, these costs continue to exceed
the technical cost of balancing the system even with consolidation.
Consolidation does not deliver an economically efficient solution;
the actual costs faced by wind generators
(and other small generators) are exceeding even the theoretical
settlement costs. The change in the commercial relationship between
small generators and purchasers of power created by NETA, is a
significant factor in depressing the prices now available to small
The Association remains concerned that a system
of market operation that is not demonstrably based upon cost-reflective
principles is discriminating against sustainable generators and
directly undermining Government's climate change policy.
None of this need have happened. The Ministerial
commissioning letter asked the energy regulator to achieve an
outcome that "encouraged" combined heat and power and
renewables. This was not done.
In the pre-budget report of November 1999, the
Chancellor made an unequivocal statement regarding the treatment
of CHP under the Climate Change Levy (CCL).
"I have decided that renewable energy sources
and combined heat and power will be exempt from the levy."
Rt Hon Gordon Brown MP, Chancellor of the Exchequer,
9 November 1999 (Hansard col 883).
The commitment to exempt CHP from the CCL remains
to be fulfilled. At present the exemption is limited to exemption
for power consumed on-site, and excludes power exports via a licensed
supplier. This omission fails to recognise that the environmental
benefits of CHP derive from the efficiency with which the power
is generated and are not dependent upon the contractual "flow"
of power or point of use. This exemption is vital in contributing
towards commercial viability of CHP schemes, particularly in the
present market circumstances.
Sustainable generation is typically small scale
and located in the distribution networks. The reform of the structure,
operation and regulation of the power networks is essential if
sustainable generation is to develop as a commercially viable,
integrated generation technology. Without such reform sustainable
generation will continue to be marginalized by the established
physical and commercial structures of the industry, now reinforced
There is an apparent lack of urgency across
Government in carrying forward the recommendations of its Embedded
Generation Working Group (EGWG). To date OFGEM has issued only
one substantive consultationaddressing interim arrangements
for connection and use-of-system charesand the EGWG's successor,
the Distributed Generation Co-ordination Group, is only just getting
underway. Compared to the resources OFGEM and the DTI committed
to NETA, the scale of activity is presently inconsequential.
DEFRA have been committed to producing a comprehensive
CHP strategy since 1997. Despite repeated reassurances that a
coherent, comprehensive CHP strategy setting out how the Government
intends to achieve its 10 GWe target would be forthcoming, the
Department has failed to produce such a document, let alone put
in place clear legislative arrangements to underpin it. This policy
vacuum creates uncertainty and difficulties for the industry,
and is used by other parts of Government as an excuse for inaction.
The DTI have estimated that every 1,000 MWe
of CHP operating results in savings of 0.97 million tonnes of
carbon per annum
through displacement of conventional, centralised power generation
and independent boiler plant. Government has a target to achieve
10,000 MWe of CHP by 2010. With installed CHP capacity of 4,600
MWe in 2000, the growth in CHP to the 2010 target will deliver
over five million tonnes of additional carbon savings. The need
to produce an effective CHP strategy that will deliver these carbon
savings is now critical.
In general, planning authorities in the UK do
not consider the development of the heat market in the context
of their planning functions. This situation contrasts with the
approach adopted towards other network utilities such as water,
sewage, gas, electricity and telecoms.
As the Royal Commission on Environmental Pollution
has highlighted, the heat load development needs to be reinforced
through the planning regime, as was highlighted in the Association's
original submission. Placing such a requirement upon authorities
would assist in identifying opportunities for the economic use
of CHP linked to district energy networks.
There has been little tangible development in
this area, and the effectiveness of DTI's guidelines on "Exploration
of the opportunities to use Combined Heat and Power, including
community heating" when developing proposals for new power
stations has been largely untested due to the downturn in development
of all forms of new power plant since the advent of NETA.
The DTI has, apparently inadvertently, included
CHP in the "Renewables Obligation Base"the volume
of electricity upon which electricity suppliers' liability for
Renewables Obligation is based. Consequently CHP is treated in
a manner identical to conventional power generation, with no recognition
of the environmental benefits that it delivers.
The net effect of these arrangements is to cause
CHP operators to subsidise the achievement of the Government's
renewables target. It will cost the industry some £100 million,
despite the major contribution that CHP already makes to reducing
UK CO2 emissions.
The solution to this paradoxical situation is
to use forthcoming energy legislation from either DTI or DEFRA
to change the legislative framework. It is understood the Secretary
of State for Trade and Industry has indicated she is prepared
to consider this. However, a firm commitment to resolve the matter
in forthcoming legislation is awaited.
A COMBINED HEAT
The Government has taken the powers under the
2000 Utilities Act to introduce an obligation for CHP similar
to that for renewables. The question is when should this be done.
The present market conditions facing CHP, and
most notably the New Electricity Trading Arrangements, are seriously
undermining the economic viability of existing CHP plant and prospects
for future investments. For renewable generators the availability
of a supplier obligation (the Renewables Obligation, or RO) has
provided some mitigation of the most severe effects of NETA. In
the absence of this Obligation it is considered unlikely that
investment in much new renewable generation would now be proceeding.
CHP faces many of the same economic obstacles
in the electricity market. In these circumstances it would be
appropriate for Government to use the powers at its disposal to
correct today's market imperfections by creating a similar market-based
mechanism for CHP as for renewables.
The RO is underpinned by a "buy-out"
price that is imposed where percentage targets are not met. Any
"buy-out" price under a CHP mechanism should properly
be set at a lower rate than that under the RO, since the RO price
was intended to reflect a number of objectives, including the
need to stimulate investment in immature technologies. The level
of the RO buy-out price has been increased to £30/MWh from
the original level of £20/MWh. The Association understands
that this increase was made in anticipation of difficult market
conditions under NETA. Since these conditions apply equally to
CHP, it would be appropriate to recognise this with a buy-out
price that would probably need to be set at £10/MWh for CHP
in today's market.
The market conditions facing CHP today are acknowledged
to be extremely difficult. Two recent studies, an EU-wide study
of CHP supported by DEFRA
and work undertaken by Cambridge Econometrics,
suggest that on current policies, UK CHP capacity will be in the
range of 6.1 to 6.6 GWe by 2010. This indicates that the Government
will miss its own target of 10 GWe of operating CHP capacity in
2010 by a margin of approximately 3.5 GWe. The environmental cost
of this failure will be the missed opportunity to realise over
three million tonnes of carbon savings per annum.
The Association regrets that the weak and inconsistent
application of the Government's commitment to sustainable development
(and its CHP target) by both OFGEM and key parts of the DTI has,
in large part, resulted in today's market conditions. This need
not have been so.
The Association welcomes the opportunity to
present this submission to the Environmental Audit Committee.
1 The views expressed in this paper cannot be taken
to represent the views of all members of the CHPA. However, they
do reflect a general consensus within the organisation. Back
Power UK, Issue 94, Platts, December 2001. Back
Penalties for Intermittent Sources of Energy, David Milborrow,
December 2001. Back
Digest of UK Energy Statistics 2001, DTI, 2001. Back
Combined Heat & Power to 2020: The Economic & Environmental
Implications of Exploiting the Potential of CHP. November